A Market Phenomenon You’re Misinterpreting and Missing Out on
Picking up where we left off yesterday, we are actually shifting gears a bit.
Short selling is a great tool when it comes to making use of the indications, however…
In this stock split guide, I’ll go over what it means for a stock to split, the effects of the split, and how you can benefit from stock splitting.
Later on, we’ll get into how shorting stock can be profitable upon gaining this sort of information.
What Is a Stock Split?
When a stock splits, the company divides its existing shares into multiple shares. It’s also referred to as a “forward split” as opposed to a reverse split, which we’ll get into later.
Have you ever seen the movie “Fantasia”?
In it, there’s an animated short called “The Sorcerer’s Apprentice” featuring an enchanted broom that Mickey Mouse chops into pieces, then the shards turn into more brooms.
That’s kind of the phenomenon with stock splitting, but with more numbers and less magic.
The split occurs when a company’s board of directors decides to increase the number of outstanding shares. They do this by issuing additional shares to current shareholders.
Despite the fact that the number of shares outstanding has increased, the total dollar amount of the shares remains the same. So by simply splitting the stock, the company doesn’t gain any value.
For example, say that a company has decided to do a 3-for-1 stock split.
Say that you currently hold 100 shares of their stock with a value of $200. When the stock splits, you will have 300 shares, but the total value will still be $200.
Why Do Stocks Split?
When a stock has a forward split, the number of shares added are typically listed by a ratio. So, if the amount of shares were doubled, it would be a 2-for-1 split. Other common ratios are 3-for-1 and 5-for-1.
Why would a company bother to do a stock split if it doesn’t increase the value of their company?
Usually, a stock split occurs in companies that have seen their share prices skyrocket to levels that they deem too high for the average trader.
The intention of a stock split is to make the shares more accessible to smaller investors without sacrificing or changing the underlying value of the company.
For an investor trading from a small account, it’s much easier to invest in shares if they are priced at $10 each versus $200, for example.
Companies including Google and Apple have split their stock in the past. But just because a company is big doesn’t necessarily mean its stock will split.
Some companies don’t split. Berkshire Hathaway A shares are known for never having stock splits. The Berkshire A shares are currently priced around $299,380.00 per share.
Alternatively, they may notice that their shares are higher-priced than those of similar companies, and they want to stay competitive.
Is a Stock Split Good?
A stock split in and of itself is actually a neutral thing. It’s a simple method of dividing the shares. However, it can be an indicator of good things to come for both the company and its investors.
The idea is that if a company’s stock price is elevated to the point where a split is required, it’s a good indication that they have potential to rise even further and that it’s a good idea to buy.
However, just because a stock has a forward split doesn’t instantly make it a great investment. There’s plenty more research that must be done to make that determination.
Advantages of Stock Splits
How could a stock split be beneficial? Let’s delve into some of the potential effects of a stock split and why it can be considered an indicator of good things to come.
More liquidity. When a stock splits, it provides more liquidity to a stock. Of course, for traders, liquidity can be a double-edged sword.
Liquidity can help a stock move, since more shares are available to buy or sell. But it’s a delicate balance.
Having too few shares can be dangerous, because the price can move so fast that just a few shares in a transaction can kill a run.
Yet having too many shares can be a problem too, because it will make it so that a stock will never change in price more than a few pennies at a time.
Overall, higher liquidity is seen as a good thing. Since most favor long stocks, the idea of a slow uptrend will be noticed in time. However, on the flip side, a little-noticed stock can see their share price erode post-split.
More affordable shares. When a stock splits, the per-share stock price is lowered. This makes the stock more affordable, which can make it appealing and available to many more buyers.
For example, if a stock is trading at $600 per share, it will shut out a lot of buyers. If you had $6,000, you would only be able to buy 10 shares! That doesn’t offer you much flexibility or much of a chance to diversify.
Because of this, few buyers with smaller accounts will go for an opportunity like that.
However, if the stock splits and the per-share price is reduced, you have the opportunity to purchase more shares and take a larger position.
So from a company’s point of view, this can be a tactical method of attracting more investors and being exposed to a greater audience.
Check back in tomorrow for real world examples of this happening… and how the market built up or destroyed companies in the aftermath.
Editor, Penny Stock Millionaires